Nearly all of us are eager to get on the property ladder and, once there, to move up a rung or two. However, whether you are a first time buyer or an existing home owner considering upgrading to a better house, it is vitally important that you apply due diligence to checking that you can afford the required mortgage.
Quite often the process that we go through is firstly to look at houses that we like and see how much of a mortgage we would need to fund the purchase. We then go to a bank and ask them how much they will lend us to see if it will meet the amount we need to raise for the purchase.
This is an understandable approach. After all, looking for your dream house is the exciting part of the house hunting process, rather than evaluating your finances. However, as we've seen with the sub-prime mortgage crisis, too many borrowers have been prepared to overstretch themselves in the quest to have their desired home (and too many banks have been prepared to lend too much).
A better approach is to work from the bottom up, by which I mean that your starting point should be to work out what monthly amount you could comfortably afford to pay into a mortgage each month. Having upgraded from an apartment to a detached house quite recently, this is a process that I have gone through and I'll outline the approach that I took.
1. Work out your existing regular costs:
By looking at a few months' bank statements, it should be relatively easy to work out how much you spend per month on things such as food, gas and electricity, phone bills, insurance, travel, and any existing borrowing. (If you're an existing home owner, you can exclude your current mortgage payments).
2. Determine your existing disposable income
By subtracting your regular costs from your monthly salary, you will arrive at a figure that represents your disposable income. Note: This is money that you may currently put into a savings account or use to pay for irregular costs, holidays, etc.
3.Work out how much you could reasonably put towards mortgage payments
I used the word reasonably' here and previously I used the word comfortably'. These are important for several reasons. Firstly, no matter how nice the house is, you don't want to be in a position where you can't afford to go on holiday or do things that make you happy such as going to restaurants, music concerts, etc. You also need to consider what would happen if an unexpected cost emerged or if the bank increased the mortgage interest rates.
It's difficult to set hard and fast rules but, for me personally, I wouldn't want to be putting much more than 50% of my disposable income towards my mortgage.
4. Translate your monthly affordable payment into what size of mortgage you could have
Let's say that you have determined that you could comfortably afford a monthly mortgage of $1,000. As a next step, I'd suggest going to a few banks' websites and checking out their mortgage calculators. These typically don't represent a formal quote but will give you an idea of how much mortgage you will be able to afford.
Some mortgage calculators allow you to enter your income and they will then display an estimate of how much the bank may be prepared to lend to you. You can then enter various mortgage amounts and terms (i.e. over how long you want to pay the mortgage off) and see what monthly payments would be required.
You may already have a house in mind by this point and a good idea of how much it is likely to sell for and therefore how much of a mortgage you would need. You also now know how much you can afford to put towards the mortgage repayments, so you should be able to come to a realistic conclusion on whether you can afford to bid on the house.
Remember, though, that these online mortgage calculators are not formal quotes, so you will need to speak to your chosen mortgage provider to get confirmation that they will give you the mortgage. You will then be well on your way to becoming a home owner and hopefully your diligence will mean that you will have no difficulty with repayments. One final thing, though, to be aware of is that sometimes mortgage providers offer an initial introductory interest rate on mortgages. You need to be aware of the standard rate that the mortgage will default to once that introductory period runs out. This is one of the factors that have contributed to the sub-prime problems as fixed rate deals run out and mortgage holders find their monthly payments suddenly jumping up.